Fight against capital outflows delays reforms – Sara Hsu

China has faced a record outflow of capital since the end of 2015. Efforts to stop that outflow, maybe needed, delay severely the planned liberalization of the financial markets, writes financial analyst Sara Hsu in the Diplomat. “The rate of change is dissatisfying to those calling for reform.”

Sara Hsu:

Chinese regulators have attempted to curb legal capital outflows from banks, requiring banks to rigorously check corporate business transactions. Furthermore, although a large percentage of capital outflows are legal due to significant openness of the capital account, remaining capital controls continue to give rise to illegal capital outflows. Regulators have been cracking down on illegal cross-border outflows disguised as trade transactions. This battle will likely continue as long as China’s economy remains weak and exchange rate expectations remain negative.

The fight against economic fragility has in important ways prolonged the reform process, especially the turn toward financial liberalization. Should interest rates be set low to improve economic conditions, or set high to reduce capital outflows? Should the exchange rate be allowed to fluctuate on speculative forces, or should instability be the controlled? Ironically, the same forces that prevail upon the RMB to depreciate would give exports a significant boost, pumping up the real economy. Despite some analysts’ beliefs that China has depreciated to buoy exports, this does not seem to be the ultimate aim. China does appear to be headed away from a manufacturing and export-based economy, but slowly. Exchange rate liberalization is occurring, but at a microscopic pace in spite of IMF’s exhortations to liberalize faster.

The rate of change is dissatisfying to those calling for reform and shocking to those who demand greater stability. These contradicting forces may last through the year as China restructures and finds a healthier balance between market and government control.